Multi-Sourcing for mid-term price reductions.

Outsourcing is all about the contract and contractual discipline (governance). But after the agreement is negotiated, clients still complain of value leakage and, given the long contract periods, risk of pricing that lags market performance over time. Sure, benchmarking is supposed to compensate, but benchmarking mechanisms can be cumbersome to exercise and slow to respond. And benckmarking tends to adjust for seriously out of date pricing, not tactical shifts in the market. Companies with sufficient scale can actually develop a competitive sourcing environment - a strategic technique called Multi Sourcing.

What's multi-sourcing? Instead of hiring a single large outsourcer (like EDS) to do an entire scope of services, large clients have the buying power to break apart contracts into smaller scopes of service. For example, I recently had a client who awarded LAN services to one Service Provider, and WAN to a different Service Provider, though either SP could have provided the combined scope, the client felt a competitive price point could be achieved without additional scope.
The client held business units out of scope and when it came time to add them into the mix of Services, approached both Service Providers to bid Services. In each case, the Service Provider was providing new Scope (e.g. the LAN SP was bidding on WAN Services, and vice-verse). The result was extremely powerful: not only was the new business unit assured of extremely competitive pricing, but the new price points, if lower than existing pricing (they were), could be leveraged for mid-term price reductions with the existing provider.

Of course, there are disadvantages to multi-sourcing. After cost reductions, customers cite “one-throat-to-choke” as their reason for outsourcing. Multi-sourcing dilutes that benefit and creates potential fingerpointing conflicts.

Multisourcing also places added burden on governance, a source of value leakage that many clients struggle with in the best of circumstances.

1. Scale. You have to have enough business to spread around. Probably the largest example of moving from an outsourced to a multi-sourced environment is General Motors. At one time 20-years ago, GM literally owned EDS. A few years ago as the contract expired, GM made a strategic decision to break apart the single EDS relationship into almost 40 parts that were ultimately awarded to dozens of Service Providers, many of which with overlapping capabilities.

2. Contractual savviness. You have to know what you’re trying to do, and execute against that goal. Without vision and strategy, you’ll be left with SLA gaps that simply can’t be filled. You’ll also want to keep committed volumes at an absolute minimum – you’ll need that volume to create competitive situations down the road.

3. Growth. Somehow, you’ll need to have blocks of additional scope that can be competitively bid – this is how you’ll get mid-term price reductions. You can either withhold business up front, or be a growing enterprise with new chunks of business. You’ll also have to have contractual restraint mid-term and not just add business incrementally but strategically source it in attractive chunks.

Multi-sourcing is an aggressive sourcing strategy. It’s a bold maneuver to request mid-term pricing concessions from a negotiated agreement. But lets face it, often the warts in a contract aren’t apparent for a while, multi-sourcing is a way to solve those when they’re discovered. But – and this is a big ‘but,’ without an equally aggressive governance structure, a multi-source strategy may result in significant service gaps.

BOT gotchas (Build/Operate/Transfer)

A BOT (build operate transfer) model is where a Service Provider is engaged to build a facility, technology, or process; achieve operational stability ('sustain' mode), then transfer it to the Client for long term operations. It can be a relatively fast transition, or can be the outcome of a traditional Outsourcing agreement, perhaps 10-years in duration.

In addition to standard cost drivers inherent in any complex services deal (SLAs, cost of capital, etc), cost drivers for a Build Operate Transfer model:

1. Who will own the assets? Client will obviously pay for them in some fashion, but whose books will they be on during the life of the term? Will it be a standalone facility (e.g. future/current Captive), or the Service Provider facility that will be transferred at the end of the term?

2. Developed software/processes/IP - ownership and transfer costs/rights, much of it will be jointly produced.

3. Disengagement Plan - how exactly does the Service Provider disengage? What if the Client seeks to replace SP #1 with another SP? Right to hire personnel should be discussed.

4. Mid-term Termination rights - Service Provider stranded costs should be understood and outlined prior to agreement.

5. Personnel. Who will be operating the facility at each level? Does Service Provider only provide management and oversight? Engineering? How does the Client even maintain a presence that can be transitioned back to Client at end of Term?

6. Facilities upgrades. Who is responsible for monitoring systems? Upgrades?

7. Business addition/reduction - ARC/RRC structure will differ from traditional outsourcing deal to reflect asset ownership and risk profile. (ARC = Additional Resource Charge' RRC = Reduced Resource Charge. These are negotiated Unit Prices for incremental business).

Overall, Service Providers are probably less interested in this business model than in traditional annuity streams, though lately there is a detectable reluctance to assume high capital costs, so the timing may be right for structuring a BOT deal - if the client assumes much of the asset risk. I’d be especially wary of hidden hooks that increase the difficulty in transferring the work at the end of the Term.